The regulator’s role and the dilemmas we face

Topic of the month: energy regulation and decarbonisation

Topic of the Month: the challenge of net zero

This Topic of the Month discusses some of the challenges regulators face in helping to achieve net zero, and the actions that Ofgem, the British energy regulator, plans to take.

Given the scale of transformation required to achieve net zero, the energy regulator is only one organisation among many that need to take action. In particular, government has a democratic mandate to set the overall direction of energy policy, and decides how to balance different objectives at the highest level. It decides how the costs of the transition will be met by consumers and taxpayers, and the overarching framework of the energy system.

Nonetheless, the GB energy regulator has a clear statutory remit to promote decarbonisation. Ofgem’s principal statutory objective is to protect the interests of current and future energy consumers, including their interests in the reduction of greenhouse gases. In relation to decarbonisation, we have critical roles in five key areas:

  • Responsibility for the evolution of energy networks.
  • Partnership with government in the evolving market design and system operation.
  • Primary responsibility for regulating retail energy markets.
  • Administering environmental and social energy schemes.
  • Showing leadership to encourage partnership between industry, regulation and government, and providing advice.

Many important trade-offs

Decarbonisation means that the energy system will reach more aspects of our lives, including transport and heat, and may require more active engagement from consumers. This brings new challenges in thinking about fairness and trade-offs. We need to consider how costs and benefits fall between different groups, in different places, and at different times. There are several specific trade-offs which we need to consider, including:

  • Balancing the needs of current and future consumers. How much should current consumers pay towards investments that promote long-term decarbonisation?
  • Balancing the distributional impacts of funding policies from consumer bills, taxpayers or others.
  • Providing support to early adopters without creating a risk of leaving some consumers behind.
  • Balancing the need to do things differently with a recognition that changes may be easier or more advantageous for some people. For instance, younger and more educated consumers might find it easier to benefit from a more flexible energy system, with time-varying prices.
  • National versus regional action. Regional action can allow for more rapid experimentation and tailoring of policies, but action at the national level can provide better coordination.

Effective carbon prices vary widely

The chart below, from the UK’s Energy Systems Catapult, illustrates some of the issues that the UK faces. As in other countries, the effective carbon price varies significantly across sectors, meaning that there are highly variable incentives to reduce emissions. As a result, incentives to buy electric heat pumps, for instance, are currently limited. Changing such incentives could lead to upheaval and protests from those who are accustomed to particular prices for activities. This provides another motivation for wanting to use a range of tools to achieve decarbonisation, rather than relying on, for instance, carbon prices alone. It also means that regulators need to look across the system as a whole when making decisions – not just considering the efficiency of signals within the areas they are directly responsible for (this can be seen as an application of the theory of the second best).

Figure 1: Effective carbon prices and emissions in the UK by sector
Figure 1: Effective carbon prices and emissions in the UK by sector

Source: Energy Systems Catapult (2019), Rethinking Decarbonisation Incentives: Future Carbon Policy for Clean Growth.

Note: Negative effective carbon prices relative to target imply that the estimated effective carbon price was below £80. Positive figures imply that the estimated carbon price was above £80

Structural questions could affect how we can achieve net zero

To achieve net zero, society may also need to consider wider structural questions of how different organisations and regulators interact. The UK’s National Infrastructure Commission recently recommended that regulatory duties should explicitly include requirements to promote the achievements of legislated emissions targets (currently net zero by 2050 in the UK). Ofgem, unlike many other regulators, does have a decarbonisation duty, but this does not explicitly discuss net zero.

The NIC also recommended that regulators should collaborate more effectively, both with each other and with government. This reflects the likelihood that, for instance, the growth of autonomous electric vehicles is likely to increase the importance of coordination across energy, transport and communications regulators.

The role of system operators is also likely to change over time, as they have to accommodate greater levels of intermittent and distribution-connected generation and more flexible demand. We recently announced a review of system operation in GB, which will consider, among other things, whether we have the right governance framework to deliver net zero at lowest cost to consumers.

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